The Treasury Market Appears To Have Exhausted The Selloff - Time To Reverse??

2 weeks ago I talk about how US Treasuries were rich vs stocks (ES in particular), and that monthly cyclicals would force treasuries to cheapen vs stocks. On Dec 6 (on my prop model) i read 10yr yields as 14 basis points rich vs stocks. At the time there were 2 reasons why i thought bonds would cheapen. 1) they were rich on the model graph 2) there were auctions coming, and the market likes to get short in front of the auctions. Over the past 2 weeks, treasuries have indeed cheapened (24 bps from peak to trough). (positive on the spread graph = 10yr cheap)

Now with the last auction of the year out of the way, and price action in the treasury market that appears to indicate an exhaustion, combined with additional price action that indicates short covering today, my prediction is that the time has come for treasuries to go back the other way (ie..time to richen vs stocks).

With year and month-end only 7 trading days away (and 2 of those are early closes for the bond market), and 10yr yields reading 6 basis points cheap as of this writing (they reached 10 bps cheap yesterday at the height of the selloff), the higher probability trade is to buy weakness in UST while simultaneously buying stocks..expecting treasuries to outperform. This trade makes no prediction about the direction of the stock market or global risk on / risk off sentiment (when stocks prices go up, we normally expect treasury prices to go down). We are just trying to capture the relative difference between asset classes. December has traditionally been a strong month-end for treasuries. The cyclicals for stocks are less clear..and the fiscal cliff drama makes this even harder to handicap...but the odds say this position should win more often than not, especially from these attractive levels.

The aggressive trade is just to get long US Treasuries...but the relative value trade is to get long both. Like most things in trading, there is no guarantee that this trade will be profitable by year-end...but i'm a betting man, and i'm betting that it will. As always, thoughts about these trades are updated on the blog and twitter...feel free to follow along.

Treasuries are screwed - the "debt" is a constant talk in Washington and the press aka - the debt is a problem that needs to be solved aka we need to declare bankruptcy on government loans aka treasuries are going to zero. The inflationists fail to realize that in order to pay the debt, we would need to print $16 trillion for treasuries alone, plus $85 trillion for other obligations. If they are going to trim other obligations down to $45 trillion, they would still need to print $56 trillion - a far cry from the current $1 trillion in annual printing that is currently in place. It seems much more politically palatable to default. Of course, they could print, but in doing so, treasuries will become nearly worthless as the money supply would have to go up by a factor of 10 driving the value of current treasuries down by 90%. To be long treasuries seems absolutely foolish either way. Considering that all of this has to happen within the next year or so, and given that the government is already on the brink of default, I think default is the safer bet. Either way, treasuries are NOT a good investment when compared to hard assets like gold and staple goods and services like utilities

Long TBT (the double short long Treasury ETF) since November 13. TBT is now overbought and nearing the top of the trading range (with ADX only 16+) which correlates with your observations. Not quite ready to reverse this trade but waiting for technical signal to do so.

So how is TBT treating you lately?? The most important lesson i've learned in trading is that once your view has changed...you must be aggressive..and that cuts both ways. There is never a time to stop being aggressive..its full steam ahead every time, all the time. Thats called "trading".

Large deposits that seek safe haven status will just park their cash in short dated US Treasury paper (bills, 2Y and 3Y notes that roll down the curve). For the next couple years, this paper will have the same safety and security of an FDIC insured bank account. My point is that the duration trade that I am referring to occurs further out the curve. Bank account type replacement vehices are very short dated. So, while its interesting to talk about for those who need to create a synthetic bank account type vehicle for very large deposits...it doesn't really have any effect on 10yr and 30yr yields. These are just 2 completely different asset classes.